Monday, March 13, 2017
8:30:15 PM EDT

Hugging the Flat Line

by
Jim Brown

The Dow and S&P failed to generate any excitement with a narrow intraday range. The Dow lost 20 points and the S&P gained less than a point. This was a very flat day with a narrow range as investors wait for the events later in the week. The Nasdaq was positive again and the strongest index. The Russell shook off its weakness to post a 5-point gain. Today was simply a watch and wait day. Volume just barely broke 6 billion shares.

The problems ahead are the FOMC meeting on the 15th, which is the same day the debt ceiling suspension expires. Either or both could present problems for the market. The chance of a March rate hike has more than tripled over the last two weeks to 91% today and that is almost a guarantee it will happen. That is sure to cause some political tweets and could upset the market.

Current Portfolio

Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow.
We need to always be prepared for an unexpected decline.

Profit Targets

Check the graphic below for any profit stops in green.
We need to always be prepared for a profit exit at resistance.

Current Position Changes

ATVI - Activision Blizzard

The long call position was entered at the open.

ITW - Illinois Tool Works

The long call position remains unopened until a trade at $135.25.

IWM - Russell 2000 ETF

The long call position remains unopened until a trade at $133.75.

If you are looking for a different type of option strategy, try these newsletters:

Activision Blizzard, Inc. develops and publishes online, personal computer (PC), video game console, handheld, mobile, and tablet games. The company operates through two segments, Activision Publishing, Inc. and Blizzard Entertainment, Inc. The company develops, publishes, and sells interactive software products and content through retail channels or digital downloads; and downloadable content to a range of gamers. It also publishes subscription-based massively multiplayer online role-playing games; and strategy and role-playing games. In addition, the company maintains a proprietary online gaming service, Battle.net that facilitates the creation of user generated content, digital distribution, and online social connectivity in its games. Further, it engages in creating original film and television content; and provides warehousing, logistical, and sales distribution services to third-party publishers of interactive entertainment software, as well as manufacturers of interactive entertainment hardware products. The company serves retailers and distributors, including mass-market retailers, consumer electronics stores, discount warehouses, game specialty stores, and consumers through third-party distribution, licensing arrangements, and direct digital purchases in the United States, Canada, Canada, the United Kingdom, France, Germany, Ireland, Italy, Sweden, Spain, the Netherlands, Australia, South Korea, China, and internationally. Company description from FinViz.com

The new Overwatch game was the fastest Blizzard title to hit 25 million registered players. Monthly active users (MAU) rose 5 million at Activision to reach 51 million. Bllizzard's MAU fell 1 million to 41 million but set a record for Q4. Kind Digital users fell from 394 million to 355 million. Since King Digital is phone games the numbers tend to be volatile. Users spent 43 billion hours playing ATVI's suite of games in Q4 compared to the 45 billion hours peopls spent watching Netflix.

Shares spiked despite weak guidance. They guided for Q1 for $1.05 billion and earnings of 18 cents. The street was looking for $1.2 billion and 31 cents. For the ful lyear they guided for $6.3 billion and $1.85 in earnings. That missed street estimates for $6.68 billion and $2.03. Fortunately, ATVI normally guides low and then crushes the estimates when they report.

Earnings May 11th.

Activision has not just one or two but seven game franchises worth more than $1 billion each. It is hard to argue with success. Also, the gamers currently playing those games are always waiting for the next version or the next big game that takes technology a step further. The gaming business is one of massively recurring revenue. They not only sell new game but expansion packs to existing games, maps, tools, and other game content that helps users better enjoy the experience.

Call of Duty, Overwatch, World of Warcraft and Destiny are cash cows that generate steady streams of recurring revenue. More than 74% of ATVI's $6.6 billion in 2016 revenue was from subscriptions, in-game purchases and other digital items where the ongoing costs are next to zero. Five years ago that number was 34%.

With $2.2 billion in annual free cash flow the company can continue to develop new content and look for other acquisitions to broaden the brand.

The company is now branching out into E-sports with an Overwatch League. There are tens of thousands of gamers that will pay just to watch a pro play their favorite games. Having those pros compete with other pros is even better.

Activision is making new highs but with everything they have going for them, I believe they will keep making new highs. The options are cheap so we do not have much to lose if the stock or market suddenly takes a turn for the worst.

In their recent earnings AZN reported $1.21 compared to estimates for $1.14. Revenue of $5.585 billion was in line with estimates.

Shares fell after the CEO warned that generic sales of Crestor were crushing sales of the original drug. Sales of Crestor were down 53% in the quarter. The company said because of the Crestor decline there would be low to mid single-digit declines in revenue in 2017 and low to mid-teens percentage decline in core EPS.

However, the company has a lot of drugs coming to market and several are "life changing" for cancer, respiratory and metabolic diseases. He said AZN was at an inflection point for the anticipated return to long-term growth built on a solid pipeline.

Earnings May 4th.

AZN just received approval from the FDA on a type-2 diabetes drug called Qtern, a once daily tablet for a disease that affects 29 million Americans. They also said Lynparza, a breast cancer treatment, proved to be more effective than chemotherapy in treating metastic breast cancer.

Investors are buying AZN for the pipeline and ignoring the decline in Crestor. They have had years for that decline to appear and now it is old news.

AZN is a slow mover and the options are cheap. If the market rolls over we will not have much at risk. If the market rebounds we should be in the money in a couple days.

Update 3/3/17: AZN entered into a deal with Sanofi to market MEDI8897 for the prevention of resipiratory synctial virus (RSV) in newborns and infants. AZN will get 120 million euros up front and 495 million upon the achievement of sales related milestones. All costs will be shared equally.

No specific news. Shares have spiked to a new high at $59.50 five times in the last eight days but cannot hold the gains. Somebody is sitting on that level with stock to sell. Eventually they will run out of shares. The minor rebound on Monday is a good sign.

Original Trade Description: March 1st

Aspen Technology, Inc., together with its subsidiaries, provides software and services to the process industries in the United States, Europe, and internationally. It operates through two segments, Subscription and Software, and Services. The company licenses integrated process optimization software solutions and associated support services designed to manage and optimize plant and process design, operational performance, and supply chain planning. Its software suites include aspenONE Engineering, and aspenONE Manufacturing and Supply Chain, which are integrated applications that allow end users to design process manufacturing environments, forecast and simulate potential actions, monitor operational performance, and manage planning and scheduling activities, as well as collaborate across these functions and activities. The company also provides software maintenance and support, professional, and training services. Its customers consist of companies, which are engaged in process industries, such as energy, chemicals, engineering, and construction, as well as consumer packaged goods, power, metals and mining, pulp and paper, pharmaceuticals, and biofuels. Aspen Technology, Inc. was founded in 1981 and is headquartered in Bedford, Massachusetts.
Company description from FinViz.com.

Aspen reported Q4 earnings of 52 cents on revenue of $119.9 million. Estimates were for 43 cents and $117.6 million. Annualized revenue rose 4.5% to $450 million at the end of the quarter. Operating margins were 50.8%. The company repurchased 1.3 million shares in the quarter for $70 million. They ended the quarter with $140 million in cash and generated $27 million in free cash flow.

Earnings April 27th.

They are a small but growing company that provides software for manufactures to optimize plant operations. They acquired a new product in the quarter called Mtell, which offers machine learning based technology.

Shares have doubled over the last 12 months and they closed at a new high on Wednesday.

No specific news. Negative forecasts about the new healthcare proposal tanked the entire drug sector. BMY lost $1.39.

Original Trade Description: February 21st

Bristol-Myers Squibb Company discovers, develops, licenses, manufactures, markets, and distributes biopharmaceutical products worldwide. It offers chemically-synthesized drug or small molecule, and biologic in various therapeutic areas, including virology comprising human immunodeficiency virus infection (HIV); oncology; immunoscience; cardiovascular; and neuroscience. Its products include Baraclude for the treatment of chronic hepatitis B virus infection; Daklinza and Sunvepra for the treatment of hepatitis C virus infection; Reyataz and Sustiva for the treatment of HIV; Empliciti, a humanized monoclonal antibody for the treatment of multiple myeloma; Erbitux, an IgG1 monoclonal antibody that blocks the epidermal growth factor receptor; Opdivo, a fully human monoclonal antibody for non-small cell lung and renal cell cancer, and melanoma; Sprycel, a tyrosine kinase inhibitor for the treatment of adults with Philadelphia chromosome-positive chronic myeloid leukemia; Yervoy, a monoclonal antibody for metastatic melanoma; Abilify, an antipsychotic agent for adults with schizophrenia, bipolar mania disorder, and depressive disorder; Orencia to treat rheumatoid arthritis; and Eliquis, an oral factor Xa inhibitor targeted at stroke prevention in atrial fibrillation. Its products pipeline includes Beclabuvir, a non-nucleoside NS5B inhibitor for the treatment of HCV; BMS-663068, an investigational compound that is being studied in HIV-1; and Prostvac, a Phase III prostate-specific antigen to treat asymptomatic or minimally symptomatic metastatic castration-resistant prostate cancer. The company has clinical trial collaborations with Calithera Biosciences, Inc. and Janssen Biotech, Inc.; and a research collaboration with GeneCentric Diagnostics, Inc. Company description from FinViz.com.

BMY reported earnings of 63 cents that missed estimates for 67 cents. They guided for 2017 for earnings of $2.70-$2.90 and analysts were expecting $2.97. The shares were crushed with a $9 drop over five days. Complicating the earnings was news that sales of two drugs were slowing because of competition. However, what was not said was that BMY has dozens of other drugs currently being sold and dozens more in the pipeline. BMY has one of the richest pipelines in the business.

Fund manager Dodge & Cox did an extensive analysis of BMY and said the recent problems have just been a temporary setback and the strong pipeline of drugs plus their immuno-oncology business makes them particularly attractive and they initiated a large position. They said BMY has capitalized on its recent problems to become a focused biopharmaceutical company that is positioned to grow.

Multiple analysts have now called BMY an acquisition target. Icahn said that was one of his reasons for opening the position.

Earnings April 27th.

Shares are starting to rebound from the $46 low and they have plenty of ground to cover. The biotech sector is actually positive over the last week as through investors believe the danger from Trump and drug prices may have passed or at least moved into a new stage.

I am choosing a $60 June option with earnings in April. The option is cheap enough that we can hold over that earnings report if we decide to do that in April. If by chance there is a big gap higher on Wednesday, switch to the $60 strike.

ITW reported earnings of $1.39 compared to estimates for $1.37. Revenue of $3.4 billion matched estimates. Earnings were impacted by a 2% hit from the strong dollar.

The company reaffirmed their 2017 guidance for organic revenue growth of up to 3.5% and revenue from $13.8 to $14.1 billion. Operating margin is expected to rise 100 basis points to 23.5%. Free cash flow is expected to be $2 billion and $1 billion will be used in 2017 for stock buybacks. Q1 earnings guidance was $1.39 to $1.49. They ended the quarter with $2.472 billion in cash.

Earnings April 26th.

The commentary was positive and stock spiked sharply after earnings. Over the next four weeks, traders took profits and shares traded sideways. On the February 13th they declared a quarterly dividend of 65 cents payable April 11th to holders on March 31st. Shares ticked higher and began to make new highs.

I believe the economy is accelerating. The Philly Fed Manufacturing Survey last week was the highest since 1984 after three months of rapid growth. The new president is doing everything he can to spur growth in the USA and this is going to be contagious throughout America. Tool demand is going to rise.

Shares spiked to a new high after the president's speech and have held those gains.

Earnings are late April and I am reaching out to June for the option (no May strikes) and because of the market weakness I am putting an entry trigger on the position. We want to make sure the stock and market are moving higher before we enter the play.

The iShares Russell 2000 ETF seeks to track the investment results of an index composed of small-capitalization U.S. equities.

The IWM has declined from more than $140 on Wednesday the 1st of March, to $135.90 as of Wednesday's close. The Russell has declined for five consecutive days. There is major support in the $133.50-$134.00 range. With the large cap indexes refusing to decline materially, we should see some buyers appear when that IWM support is reached. Secondary support is about $130.50. We will use a break of that level as evidence the trade is broken and I will place the stop loss slightly below $130.

The small caps rallied 21% after the election and after today's decline that has dropped to 15%. The small caps were the most bullish because the president's policies will benefit small businesses the most. This is why I do not believe the Russell will go into full meltdown mode.

The risk to this trade is that the tax overhaul gets pushed well into the future, possibly 2018. That could happen because of the war currently underway on the new healthcare proposal. If the proposal does not get a vote within the next 30-45 days, the wheels will come off the effort and the president's agenda dies a slow death. Democrats have vowed to slow walk it and stop it if possible.

The second risk is the expiration of the debt ceiling suspension on March 15th. This is not currently being discussed in the news headlines but once it arrives it could be another congressional disaster.

I considered buying puts on the SPY/IWM, etc because of these problems. However, premiums are already high and the large cap indexes are showing strong relative strength. I believe any dip over the next several days will be shallow and brief. If the risks above materialize it should be weeks from now and hopefully after an initial rebound has formed. That will give us an opportunity to exit if the market turns negative again.

Obviously, all of this is just speculation. Nobody can accurately pick market direction in advance. We try hard but the market has a mind of its own. This is a speculative recommendation. Do not enter the position if you cannot afford to lose all or part of your premium.

Paycom targets companies in the 50-2000 employee range in order to provide HR and payroll processing. Companies do not have the time or the manpower to keep up with the impact of Obamacare on employees and the company. As the new administration moves away from Obamacare and into some other form of health service, there will be significant uncertainty along the way as old rules change and new rules are implemented. Paycom provides their Affordable Care Act (ACA) dashboard application that tracks everything Obamacare related. This is giving Paycom a boost. The company guided for a 28% increase in revenue in 2017.

For Q1 they guided for revenues of $114.5 to $116.5 million. Analysts were expecting $114 million. For the full year, the company guided for $422 to $424 million in revenue compared to estimates for $417 million.

Shares spiked to $52 after the Feb-9th earnings and have moved up steadily to $55 and a new high. There is nothing to keep the shares from moving higher given the raised guidance and strong performance. The Obamacare uncertainty will continue to be a tailwind for the company.

No specific news. Shares did not decline despite a continued drop in oil prices.

Original Trade Description: March 9th

U.S. Silica Holdings, Inc. produces and sells commercial silica in the United States. The company operates through two segments, Oil & Gas Proppants and Industrial & Specialty Products. It offers whole grain commercial silica products to be used as fracturing sand in connection with oil and natural gas recovery; and resin coated proppants, as well as sells its whole grain silica products in various size distributions, grain shapes, and chemical purity levels for manufacturing glass products. The company also provides ground commercial silica products for use in plastics, rubber, polishes, cleansers, paints, glazes, textile fiberglass, and precision castings; and fine ground silica for use in premium paints, specialty coatings, sealants, silicone rubber, and epoxies. In addition, it offers other industrial mineral products, such as aplite, a mineral used to produce container glass and insulation fiberglass; and adsorbent made from a mixture of silica and magnesium for preparative and analytical chromatography applications. The company serves oil and gas recovery markets; and industrial end markets with customers involved in the production of glass, building products, foundry products, chemicals, and fillers and extenders. Company description from FinViz.com.

Silica sells sand to drillers. The drilling activity has increased 50% since the low in May. The active rig count declined to 404 on May 27th and has rebounded to 756 as of last week. Many of these reactivated rigs are completing previously drilled wells that were never fracked and put in production. The IEA said there were more than 5,000 of these wells at the end of December. It only takes a few days to reopen a well and prepare it for fracturing and then move to the next. The sand demand to fracture these wells is off the charts.

Since the drilling boom in 2014 the amount of sand used in fracturing a well has risen about 400% because of two years of additional data and refinement of the process. A current well with a two-mile lateral requires as much sand as a 100 rail car train, called a unit train.

Sand providers claim they have drillers trying to lock in sand prices for a year in advance but there is not enough sand available to fill the demand. Prices are expected to rise 40% in the first half of 2017. Multiple analysts predict a sand shortage in 2018 with another 50% or more rise in prices.

U.S. Silica was crushed in late February when they missed on earnings. They spent a lot of money in the quarter acquiring additional sand reserves and merging in acquisitions from earlier in the year. They spent 2016 acquiring other sand companies and operations around the country so they would be ready when the drilling boom returned.

They were crushed again this week when oil prices fell 7% in just two days to the lows for the year.

Oil prices are down on record inventory levels. Inventories rose by 8.2 million barrels to 528.4 million barrels on Wednesday. However, this ALWAYS happens in Feb/Mar. Refiners go offline for spring maintenance in this slow demand period. For two months, inventories build until they restart at the end of March and begin consuming huge amounts of oil to make summer blend gasoline. The price of crude always declines in this period.

If I could, I would buy a longer dated call and hold on to this position until fall. However, this newsletter is not a buy and hold strategy. I am going to recommend the June calls and we will exit before the May earnings.

Earnings May 24th.

The decline over the last two days knocked the stock back to the 200-day and support from November.

Varian reported lower than expected earnings on January 26th and shares fell -$6 to $87. Two days later, they spun off Varex and shares fell to $77 as a result of the separation. Since that split the stock has been moving higher and the rate of climb has accelerated over the last two weeks as they signed multiple new deals around the world.

Varian guided for earnings of $2.94-$3.06 for Q2 through Q4. For Q2 earnings are expected to be 84-90 cents on a 4% to 5% increase in revenues. The split at the end of January complicates apples to apples comparisons for Q1.

Earnings April 26th.

On February 13th the company announced competitive bid wins for six Shanghai hospitals. Varian is the leading manufacturer of medical devices and software for treating cancer and will provide its state of the art advanced radiotherapy technology to those hospitals. On February 14th, Varian's Eclipse treatment planning software was named the 2017 category leader for oncology treatment planning by KLAS. KLAS is an independent research firm specializing in monitoring and reporting on healthcare vendors.

Varian is on track to return to its pre-split price of $90 if the current rally continues. Because of its decline in February, I believe it offers some protection against a potential market decline.

The VIX continued to decline as the market rebounded from the intraday lows. This market will not go down. Wednesday is going to be the key with the Fed meeting and debt ceiling expiration.

I think we need to hold this position as insurance against a larger decline that stops out other positions. If we ever do get a material drop, we will be glad we are holding the VIX calls.

Original Trade Description: Jan 26th

The VIX is a computed index, much like the S&P 500 itself, although it is not derived based on stock prices. Instead, it uses the price of options on the S&P 500, and then estimates how volatile those options will be between the current date and the option's expiration date. The CBOE combines the price of multiple options and derives an aggregate value of volatility, which the index tracks.

The VIX closed at 10.63 and very close to record lows. You have to go back to June of 2014 for a lower recent close at 10.28. Before that, you have to travel back in time to Feb-2007 for a close at 10.05. The next lowest close was 9.48 in Dec-1993.

The point here is that volatility is near record lows only reached four times in the last 23 years. That qualifies for an abnormal event. I believe it is time we bought some VIX calls. The odds of the VIX remaining this low for the next two months are about as close to zero as you can get.

There is a very old saying in the market. "When the VIX is high, it is time to buy. When the VIX is low, it is time to go." You cannot get much lower than this.

The VIX is telling us that everyone expects the market to continue moving higher. Nobody is worried that some unexpected headline or event is going to trigger a significant market decline. When nobody expects an event is when we should be the most concerned.

Target Corporation operates as a general merchandise retailer. It offers household essentials, including pharmacy, beauty, personal care, baby care, cleaning, and paper products; music, movies, books, computer software, sporting goods, and toys, as well as electronics, such as video game hardware and software; and apparel for women, men, boys, girls, toddlers, infants, and newborns, as well as intimate apparel, jewelry, accessories, and shoes. The company also provides food and pet supplies comprising dry grocery, dairy, frozen food, beverages, candy, snacks, deli, bakery, meat, produce, and pet supplies; and home furnishings and decor, including furniture, lighting, kitchenware, small appliances, home decor, bed and bath, home improvement, and automotive products, as well as seasonal merchandise, such as patio furniture and holiday decor. In addition, it offers in-store amenities, including Target Cafe, Target Photo, Target Optical, Portrait Studio, Starbucks, and other food service offerings. Target Corporation sells products through its stores; and digital channels, including Target.com.
Company description from FinViz.com.

Target reported earnings of $1.46 compared with $2.31 in the year ago quarter. Analysts estimates were $1.50. Full year earnings of $4.58 was also below the 2015 total of $5.25. Sales for the holiday quarter declined -4.3% to $20.7 billion and also missed estimates.
The company guided for 2017 same store sales to decline in low single digits with earnings at a mid range of $4.00, also below the 2016 total. Q4 same store sales fell -1.5%. For Q1 they guided for earnings of 80 cents to $1, below the year ago $1.29 and analyst estimates for $1.31. For the same period, Walmart saw same store sales rise 11.8%.

Earnings May 30th.

Shares are crashing because investors are worried Target will turn into Sears with the monster stores becoming ghost towns similar to the deserted stores operated by Sears. With guidance moving lower, analyst estimates moving lower and the biggest shopping quarter of the year behind them, it could be a long hot summer for Target's share price. Shares closed at a five-year low on Tuesday after breaking support at $56.

Yelp Inc. operates a platform that connects people with local businesses primarily in the United States. Its platform covers various local business categories, including restaurants, shopping, beauty and fitness, arts, entertainment and events, home and local services, health, nightlife, travel and hotel, auto, and others categories. The company provides free and paid business listing services to businesses of various sizes, as well as enables businesses to deliver targeted search advertising to large local audiences through its Website and mobile app. It also provides other services, including Yelp platform, which allows consumers to transact directly on Yelp; Yelp deals that allow local business owners to create promotional discounted deals for their products and services; and gift certificates products for local business owners to sell full-price gift certificates directly to customers. The company's Yelp platform enables consumers to complete food delivery transactions, book spa and salon appointments, order flowers, make winery reservations, and others. It also serves customers in Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, the Czech Republic, Denmark, Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, Mexico, the Netherlands, New Zealand, Norway, the Philippines Poland, Portugal, Singapore, Spain, Sweden, Switzerland, Turkey, and the United Kingdom.
Company description from FinViz.com.

Yelp reported earnings on February 9th of 27 cents that easily beat estimates for 25 cents. Revenue of $194.8 million barely beat estimates for $194.3 million. With an earnings beat you would have expected the stock to rally strongly. That was not the case.

The company guided to revenue of $195-$199 million and analysts were looking for $204.4 million. Full year guidance was $880-$900 million.

The challenge was slowing growth. In Q2 they added 7,400 accounts. In Q3 6,600 accounts and in Q4 only 2,800 accounts. Yelp says its addressable universe is more than 20 million local businesses but they only have 138,000 active advertisers. It is far too soon for growth to be slowing at that fast a pace.

They are also seeing a decline in website traffic and app usage.

The problem is competition. Amazon, Google and Facebook are breaking into the market with new offerings. Other copycat sites like Munch Ado are stealing their customers.

Yelp pulled back from its focus on national brands and is concentrating on local business advertising, which is the bulk of their business. They are aggressively cutting costs as evidenced by the earnings beat but that only works so long if the new advertiser growth is slowing and consumer usage is fading.

Piper Jaffray called the guidance lackluster and said a "confluence of factors" will cause further decline in Yelp traffic in the future.

Earnings May 11th.

Shares have been declining steadily since earnings and have now moved under support at $35.

Position 2/23/17:

Long APR $33 put @ $1.55, see portfolio graphic for stop loss.

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